Operational effectiveness versus strategic positioning

For at least the past decade, managers have been preoccupied with improving

operational effectiveness. Through programs such as TQM, time-based competition, and

benchmarking, they have changed how they perform activities in order to eliminate

inefficiencies, improve customer satisfaction, and achieve best practice. Hoping to keep up

with shifts in the productivity frontier, managers have embraced continuous improvement,

empowerment, change management, and the so-called learning organization. The

popularity of outsourcing and the virtual corporation reflect the growing recognition that it

cost, aggressive purchasing to minimize material costs, and in-house parts production

whenever the economics dictate.

Mapping activity systems

Activity-system maps, such as this one for lkea, show how a company’s

strategic position is contained in a set of tailored activities designed to

deliver it. In companies with a clear strategic position, a number of higher-

order strategic themes (in dark grey) can be identified and implemented

through clusters of tightly linked activities (in light grey).

Yet Bic goes beyond simple consistency because its activities are reinforcing. For

example, the company uses point-of-sale displays and frequent packaging changes to

stimulate impulse buying. To handle point-of-sale tasks, a company needs a large sales

force. Bic’s is the largest in its industry, and it handles point-of-sale activities better than its

rivals do. Moreover, the combination of point-of-sale activity, heavy television advertising,

and packaging changes yields far more impulse buying than any activity in isolation could.

Vanguard’s activity system

Yet Bic goes beyond simple consistency because its activities are reinforcing. For

example, the company uses point-of-sale displays and frequent packaging changes to

stimulate impulse buying. To handle point-of-sale tasks, a company needs a large sales

force. Bic’s is the largest in its industry, and it handles point-of-sale activities better than its

rivals do. Moreover, the combination of point-of-sale activity, heavy television advertising,

and packaging changes yields far more impulse buying than any activity in isolation could.

Vanguard’s activity system

Activity-system maps can be useful for examining and strengthening

strategic fit. A set of basic questions should guide the process. First, is each

activity consistent with the overall positioning—the varieties produced, the

needs served, and the type of customers accessed? Ask those responsible for

each activity to identify how other activities within the company improve or

detract from their performance. Second, are there ways to strengthen how

activities and groups of activities reinforce one another? Finally, could

changes in one activity eliminate the need to perform others?

Third-order fit goes beyond activity reinforcement to what I call optimization of effort.

The Gap, a retailer of casual clothes, considers product availability in its stores a critical

element of its strategy. The Gap could keep products either by holding store inventory or

by restocking from warehouses. The Gap has optimized its effort across these activities by

restocking its selection of basic clothing almost daily out of three warehouses, thereby

minimizing the need to carry large in-store inventories. The emphasis is on restocking

because the Gap’s merchandising strategy sticks to basic items in relatively few colors.

While comparable retailers achieve turns of three to four times per year, the Gap turns its

inventory seven and a half times per year. Rapid restocking, moreover, reduces the cost of

implementing the Gap’s short model cycle, which is six to eight weeks long.3

Southwest Airlines’ activity system

Coordination and information exchange across activities to eliminate redundancy and

minimize wasted effort are the most basic types of effort optimization. But there are higher

levels as well. Product design choices, for example, can eliminate the need for after-sale

service or make it possible for customers to perform service activities themselves.

Similarly, coordination with suppliers or distribution channels can eliminate the need for

some in-house activities, such as end-user training.

In all three types of fit, the whole matters more than any individual part. Competitive

advantage grows out of the entire system of activities. The fit among activities substantially

established brand identities, or cumulative experience that has allowed incumbents to learn

how to produce more efficiently. Entrants try to bypass such advantages. Upstart

discounters such as Target and Wal-Mart, for example, have located stores in freestanding

sites rather than regional shopping centers where established department stores were well

entrenched.

The five forces that shape industry competition

6. Unequal access to distribution channels. The new entrant must, of course, secure

distribution of its product or service. A new food item, for example, must displace others

from the supermarket shelf via price breaks, promotions, intense selling efforts, or some

other means. The more limited the wholesale or retail channels are and the more that

existing competitors have tied them up, the tougher entry into an industry will be.

Sometimes access to distribution is so high a barrier that new entrants must bypass

distribution channels altogether or create their own. Thus, upstart low-cost airlines have

THE AVERAGE RETURN on invested capital varies markedly from industry

to industry. Between 1992 and 2006, for example, average return on invested

capital in U.S. industries ranged as low as zero or even negative to more than

50%. At the high end are industries like soft drinks and prepackaged software,

which have been almost six times more profitable than the airline industry over the

period.

Average return on invested capital in U.S. industries, 1992–

2006

Return on invested capital (ROIC) is the appropriate measure of

profitability for strategy formulation, not to mention for equity investors.

Return on sales or the growth rate of profits fail to account for the capital

required to compete in the industry. Here, we utilize earnings before interest

and taxes divided by average invested capital less excess cash as the

measure of ROIC. This measure controls for idiosyncratic differences in

capital structure and tax rates across companies and industries.

Source: Standard & Poor’s, Compustat, and author’s calculations

Profitability of selected U.S. industries

Average ROIC, 1992–2006

quality. Would we still want to put quality on our list of core values?” The members of the

management team looked around at one another and finally said no. Quality stayed in the

strategy of the company, and quality-improvement programs remained in place as a

mechanism for stimulating progress; but quality did not make the list of core values.

Articulating a vision

The same group of executives then wrestled with leading-edge innovation as a core

value. The CEO asked, “Would we keep innovation on the list as a core value, no matter

how the world around us changed?” This time, the management team gave a resounding

yes. The managers’ outlook might be summarized as, “We always want to do leading-edge

Creating a customer value proposition

It’s not possible to invent or reinvent a business model without first identifying a clear

customer value proposition. Often, it starts as a quite simple realization. Imagine, for a

moment, that you are standing on a Mumbai road on a rainy day. You notice the large

number of motor scooters snaking precariously in and out around the cars. As you look

more closely, you see that most bear whole families—both parents and several children.

Your first thought might be “That’s crazy!” or “That’s the way it is in developing countries

—people get by as best they can.”

The Elements of a Successful Business Model

EVERY SUCCESSFUL COMPANY ALREADY operates according to an

effective business model. By systematically identifying all of its constituent parts,

executives can understand how the model fulfills a potent value proposition in a

profitable way using certain key resources and key processes. With that

understanding, they can then judge how well the same model could be used to

fulfill a radically different CVP—and what they’d need to do to construct a new

one, if need be, to capitalize on that opportunity.

When Ratan Tata of Tata Group looked out over this scene, he saw a critical job to be

done: providing a safer alternative for scooter families. He understood that the cheapest

car available in India cost easily five times what a scooter did and that many of these

families could not afford one. Offering an affordable, safer, all-weather alternative for

Identifying key resources and processes

Having articulated the value proposition for both the customer and the business, companies

must then consider the key resources and processes needed to deliver that value. For a

professional services firm, for example, the key resources are generally its people, and the

key processes are naturally people related (training and development, for instance). For a

packaged goods company, strong brands and well-selected channel retailers might be the

key resources, and associated brand-building and channel-management processes among

the critical processes.

Hilti Sidesteps Commoditization

HILTI IS CAPITALIZING ON a game-changing opportunity to increase

profitability by turning products into a service. Rather than sell tools (at lower and

lower prices), it’s selling a “just-the-tool-you-need-when-you-need-it, no-repair-

or-storage-hassles” service. Such a radical change in customer value proposition

required a shift in all parts of its business model.

Oftentimes, it’s not the individual resources and processes that make the difference but

their relationship to one another. Companies will almost always need to integrate their key

resources and processes in a unique way to get a job done perfectly for a set of

customers. When they do, they almost always create enduring competitive advantage.

Focusing first on the value proposition and the profit formula makes clear how those

resources and processes need to interrelate. For example, most general hospitals offer a

value proposition that might be described as, “We’ll do anything for anybody.” Being all

things to all people requires these hospitals to have a vast collection of resources

(specialists, equipment, and so on) that can’t be knit together in any proprietary way. The

result is not just a lack of differentiation but dissatisfaction.

By contrast, a hospital that focuses on a specific value proposition can integrate its

How Dow Corning Got Out of Its Own Way

When business model innovation is clearly called for, success lies not only in getting the

model right but also in making sure the incumbent business doesn’t in some way prevent

the new model from creating value or thriving. That was a problem for Dow Corning when

it built a new business unit—with a new profit formula—from scratch.

Dow Corning Embraces the Low End

TRADITIONALLY HIGH-MARGIN DOW CORNING found new

opportunities in low-margin offerings by setting up a separate business unit that

operates in an entirely different way. By fundamentally differentiating its low-end

and high-end offerings, the company avoided cannibalizing its traditional business

even as it found new profits at the low end.

Toward Blue Ocean Strategy

What kind of strategic logic is needed to guide the creation of blue oceans? To answer that

question, we looked back over 100 years of data on blue ocean creation to see what

patterns could be discerned. Some of our data are presented in “A snapshot of blue ocean

creation.” It shows an overview of key blue ocean creations in three industries that closely

touch people’s lives: autos—how people get to work; computers—what people use at

work; and movie theaters—where people go after work for enjoyment. We found that:

A snapshot of blue ocean creation

This table identifies the strategic elements that were common to blue ocean

creations in three different industries in different eras. It is not intended to be

comprehensive in coverage or exhaustive in content. We chose to show American

industries because they represented the largest and least-regulated market during

our study period. The pattern of blue ocean creations exemplified by these three

industries is consistent with what we observed in the other industries in our study.

*Driven by value pioneering does not mean that technologies were not involved.

Rather, it means that the defining technologies used had largely been in existence,

whether in that industry or elsewhere.

following the conventional logic of outpacing the competition by offering a better solution to

the given problem—creating a circus with even greater fun and thrills—it redefined the

problem itself by offering people the fun and thrill of the circus and the intellectual

sophistication and artistic richness of the theater.

In designing performances that landed both these punches, Cirque had to reevaluate the

components of the traditional circus offering. What the company found was that many of

the elements considered essential to the fun and thrill of the circus were unnecessary and in

many cases costly. For instance, most circuses offer animal acts. These are a heavy

economic burden, because circuses have to shell out not only for the animals but also for

their training, medical care, housing, insurance, and transportation. Yet Cirque found that

the appetite for animal shows was rapidly diminishing because of rising public concern

about the treatment of circus animals and the ethics of exhibiting them.

Red ocean versus blue ocean strategy

The imperatives for red ocean and blue ocean strategies are starkly different.

Similarly, although traditional circuses promoted their performers as stars, Cirque

realized that the public no longer thought of circus artists as stars, at least not in the movie

star sense. Cirque did away with traditional three-ring shows, too. Not only did these

create confusion among spectators forced to switch their attention from one ring to

another, they also increased the number of performers needed, with obvious cost

implications. And while aisle concession sales appeared to be a good way to generate

revenue, the high prices discouraged parents from making purchases and made them feel

they were being taken for a ride.

Cirque found that the lasting allure of the traditional circus came down to just three

factors: the clowns, the tent, and the classic acrobatic acts. So Cirque kept the clowns,

while shifting their humor away from slapstick to a more enchanting, sophisticated style. It

glamorized the tent, which many circuses had abandoned in favor of rented venues.

Realizing that the tent, more than anything else, captured the magic of the circus, Cirque

designed this classic symbol with a glorious external finish and a high level of audience

Barriers to Imitation

Companies that create blue oceans usually reap the benefits without credible challenges for

ten to 15 years, as was the case with Cirque du Soleil, Home Depot, Federal Express,

Southwest Airlines, and CNN, to name just a few. The reason is that blue ocean strategy

creates considerable economic and cognitive barriers to imitation.

The simultaneous pursuit of differentiation and low cost

A blue ocean is created in the region where a company’s actions favorably affect

both its cost structure and its value proposition to buyers. Cost savings are made

from eliminating and reducing the factors an industry competes on. Buyer value is

lifted by raising and creating elements the industry has never offered. Over time,

costs are reduced further as scale economies kick in, due to the high sales

volumes that superior value generates.

second-guessing decisions made at lower levels, costing the company opportunities in fast-

moving markets.

Pricing, for example, was based on cost and determined not by market realities but by

the pricing general office in Peoria. Sales representatives across the world lost sale after

sale to Komatsu, whose competitive pricing consistently beat Caterpillar’s. In 1982, the

company posted the first annual loss in its almost-60-year history. In 1983 and 1984, it

lost $1 million a day, seven days a week. By the end of 1984, Caterpillar had lost a billion

dollars. By 1988, then-CEO George Schaefer stood atop an entrenched bureaucracy that

was, in his words, “telling me what I wanted to hear, not what I needed to know.” So, he

convened a task force of “renegade” middle managers and tasked them with charting

Caterpillar’s future.

What matters most to strategy execution

When a company fails to execute its strategy, the first thing managers often think

to do is restructure. But our research shows that the fundamentals of good

execution start with clarifying decision rights and making sure information flows

where it needs to go. If you get those right, the correct structure and motivators

often become obvious.

Ironically, the way to ensure that the right information flowed to headquarters was to

make sure the right decisions were made much further down the organization. By

delegating operational responsibility to the people closer to the action, top executives were

free to focus on more global strategic issues. Accordingly, the company reorganized into

business units, making each accountable for its own P&L statement. The functional general

offices that had been all-powerful ceased to exist, literally overnight. Their talent and

expertise, including engineering, pricing, and manufacturing, were parceled out to the new

business units, which could now design their own products, develop their own

manufacturing processes and schedules, and set their own prices. The move dramatically

decentralized decision rights, giving the units control over market decisions. The business

unit P&Ls were now measured consistently across the enterprise, as return on assets

became the universal measure of success. With this accurate, up-to-date, and directly

comparable information, senior decision makers at headquarters could make smart

strategic choices and trade-offs rather than use outdated sales data to make ineffective,

tactical marketing decisions.

The 17 fundamental traits of organizational effectiveness

From our survey research drawn from more than 26,000 people in 31

companies, we have distilled the traits that make organizations effective at

implementing strategy. Here they are, in order of importance.

Within 18 months, the company was working in the new model. “This was a revolution

that became a renaissance,” Owens recalls, “a spectacular transformation of a kind of

sluggish company into one that actually has entrepreneurial zeal. And that transition was

very quick because it was decisive and it was complete; it was thorough; it was universal,

worldwide, all at one time.”

supporting Unit A’s effort.

Mapping improvements to the building blocks: some

sample tactics

Companies can take a host of steps to improve their ability to execute strategy.

The 15 here are only some of the possible examples. Every one strengthens one

or more of the building blocks executives can use to improve their strategy-

execution capability: clarifying decision rights, improving information, establishing

the right motivators, and restructuring the organization.

The company had initiated a number of enterprisewide projects over the years, which

had been completed on time and on budget, but these often had to be reworked because

stakeholder needs hadn’t been sufficiently taken into account. After launching a shared-

services center, for example, the company had to revisit its operating model and processes

No one had a good idea of the decisions and actions

for which he or she was responsible. The general lack of

information flow extended to decision rights, as few managers understood where their

authority ended and another’s began. Accountability even for day-to-day decisions was

unclear, and managers did not know whom to ask for clarification. Naturally, confusion

over decision rights led to second-guessing. Fifty-five percent of respondents felt that

decisions were regularly second-guessed at Goodward.

To Goodward’s credit, its top executives immediately responded to the results of the

diagnostic by launching a change program targeted at all three problem areas. The program

integrated early, often symbolic, changes with longer-term initiatives, in an effort to build

momentum and galvanize participation and ownership. Recognizing that a passive-

aggressive attitude toward people perceived to be in power solely as a result of their

Translation vision and strategy: four perspectives

Translating the Vision

The CEO of an engineering construction company, after working with his senior

management team for several months to develop a mission statement, got a phone call from

a project manager in the field. “I want you to know,” the distraught manager said, “that I

believe in the mission statement. I want to act in accordance with the mission statement.

I’m here with my customer. What am I supposed to do?”

Managing strategy: four processes

The mission statement, like those of many other organizations, had declared an intention

to “use high-quality employees to provide services that surpass customers’ needs.” But the

project manager in the field with his employees and his customer did not know how to

translate those words into the appropriate actions. The phone call convinced the CEO that

a large gap existed between the mission statement and employees’ knowledge of how their

day-to-day actions could contribute to realizing the company’s vision.

Metro Bank (not its real name), the result of a merger of two competitors, encountered

a similar gap while building its balanced scorecard. The senior executive group thought it

had reached agreement on the new organization’s overall strategy: “to provide superior

service to targeted customers.” Research had revealed five basic market segments among

existing and potential customers, each with different needs. While formulating the measures

for the customer-perspective portion of their balanced scorecard, however, it became

apparent that although the 25 senior executives agreed on the words of the strategy, each

one had a different definition of superior service and a different image of the targeted

customers.

How one company built a strategic management system . . .

. . . around the balanced scorecard

The exercise of developing operational measures for the four perspectives on the bank’s

scorecard forced the 25 executives to clarify the meaning of the strategy statement.

Ultimately, they agreed to stimulate revenue growth through new products and services and

also agreed on the three most desirable customer segments. They developed scorecard

measures from the four perspectives.”) The company found significant correlations

between employees’ morale, a measure in the learning-and-growth perspective, and

customer satisfaction, an important customer perspective measure. Customer satisfaction,

in turn, was correlated with faster payment of invoices—a relationship that led to a

substantial reduction in accounts receivable and hence a higher return on capital employed.

The company also found correlations between employees’ morale and the number of

suggestions made by employees (two learning-and-growth measures) as well as between

an increased number of suggestions and lower rework (an internal-business-process

measure). Evidence of such strong correlations help to confirm the organization’s business

strategy. If, however, the expected correlations are not found over time, it should be an

indication to executives that the theory underlying the unit’s strategy may not be working as

they had anticipated.

Especially in large organizations, accumulating sufficient data to document significant

correlations and causation among balanced scorecard measures can take a long time—

months or years. Over the short term, managers’ assessment of strategic impact may have

to rest on subjective and qualitative judgments. Eventually, however, as more evidence

accumulates, organizations may be able to provide more objectively grounded estimates of

cause-and-effect relationships. But just getting managers to think systematically about the

assumptions underlying their strategy is an improvement over the current practice of

making decisions based on short-term operational results.

How one company linked measures from the four

perspectives

Third, the scorecard facilitates the strategy review that is essential to strategic learning.

mimic its rivals’ ultimately unsuccessful strategies if it hadn’t had its own strategic principle

to follow: “Meet customers’ short-haul travel needs at fares competitive with the cost of

automobile travel.” Likewise, eBay, whose principle is “Focus on trading communities,”

might have been tempted, like many Internet marketplaces, to diversify into all sorts of

services. But eBay has chosen to outsource certain services—for instance, management of

the photos that sellers post on the site to illustrate the items they put up for bid—while it

continues to invest in services like Billpoint, which lets sellers accept credit-card payments

from bidders. EBay’s strategic principle has ensured that the entire company stays focused

on the core trading business.

The staggering pace of technological change over the past decade has been costly for

companies that don’t have a strategic principle. Never before in business has there been

more uncertainty combined with so great an emphasis on speed. Managers in high-tech

industries in particular must react immediately to sudden and unexpected developments.

Often, the sum of the reactions across the organization ends up defining the company’s

strategic course. A strategic principle—for example, Dell’s mandate to sell direct to end

users—helps ensure that the decisions made by frontline managers in such circumstances

add up to a consistent, coherent strategy.

It’s all in a phrase

A handful of companies have distilled their strategy into a phrase and have

used it to drive consistent strategic action throughout their organizations.

Finally, a strategic principle can help provide continuity during periods of organizational

turmoil. An increasingly common example of turmoil in this era of short-term CEOs is

leadership succession. A new CEO can bring with him or her a new strategy—but not

necessarily a new strategic principle. For instance, when Jack Brennan took over as

chairman and CEO at Vanguard five years ago, the strategic transition was seamless,

despite some tension around the leadership transition. He maintained the mutual fund

company’s strategic principle—“Unmatchable value for the investor-owner”—thereby

allowing managers to pursue their strategic objectives without many of the distractions so

often associated with leadership changes. (For our own experience with organizational

turmoil and strategic principles, see the sidebar “Bain & Company: Case Study of a

Strategic Principle.”)

Bain & Company: Case Study of a Strategic

Companies rarely track performance against long-

term plans

In our experience, less than 15% of companies make it a regular practice to go back and

compare the business’s results with the performance forecast for each unit in its prior

years’ strategic plans. As a result, top managers can’t easily know whether the projections

that underlie their capital-investment and portfolio-strategy decisions are in any way

predictive of actual performance. More important, they risk embedding the same

disconnect between results and forecasts in their future investment decisions. Indeed, the

fact that so few companies routinely monitor actual versus planned performance may help

explain why so many companies seem to pour good money after bad—continuing to fund

losing strategies rather than searching for new and better options.

Where the performance goes

This chart shows the average performance loss implied by the importance

ratings that managers in our survey gave to specific breakdowns in the

planning and execution process.

A lot of value is lost in translation

Given the poor quality of financial forecasts in most strategic plans, it is probably not

surprising that most companies fail to realize their strategies’ potential value. As we’ve

mentioned, our survey indicates that, on average, most strategies deliver only 63% of their

potential financial performance. And more than one-third of the executives surveyed

placed the figure at less than 50%. Put differently, if management were to realize the full

potential of its current strategy, the increase in value could be as much as 60% to 100%!

The venetian blinds of business

This figure illustrates a dynamic common to many companies. In January

2001, management approves a strategic plan (Plan 2001) that projects

modest performance for the first year and a high rate of performance

thereafter, as shown in the first solid line. For beating the first year’s

projection, the unit management is both commended and handsomely

rewarded. A new plan is then prepared, projecting uninspiring results for the

first year and once again promising a fast rate of performance improvement

thereafter, as shown by the second solid line (Plan 2002). This, too, succeeds

only partially, so another plan is drawn up, and so on. The actual rate of

performance improvement can be seen by joining the start points of each

plan (the dotted line).

As illustrated in “Where the performance goes,” the strategy-to-performance gap can

be attributed to a combination of factors, such as poorly formulated plans, misapplied

resources, breakdowns in communication, and limited accountability for results. To

elaborate, management starts with a strategy it believes will generate a certain level of

financial performance and value over time (100%, as noted in the exhibit). But, according

to the executives we surveyed, the failure to have the right resources in the right place at

the right time strips away some 7.5% of the strategy’s potential value. Some 5.2% is lost to

poor communications, 4.5% to poor action planning, 4.1% to blurred accountabilities, and

so on. Of course, these estimates reflect the average experience of the executives we